What would Grexit mean for the Eurozone and UK economies?
July 01, 2015
The economic and financial situation in Greece has taken a turn for the worse in the past week with the announcement of a Referendum on the bailout terms and conditions, the closure of the banks and the imposition of credit controls. Even before these developments, forecasters were expecting Greek GDP to fall this year, but a much sharper decline in output now seems likely, coupled with more financial and political turmoil.
If the Referendum result is No – the result that the Greek government is campaigning for – a much more prolonged disruption to the financial system is likely and it is hard to see how Greece could remain a euro area member. If the result is Yes – i.e. in favour of accepting the terms imposed by the creditor institutions – there will still be a major challenge in agreeing and implementing a detailed reform programme and rebuilding economic and financial confidence. A Yes vote would probably mean the end of the Syriza government, fresh elections and more political upheaval. None of this would be positive for the Greek economy in the short-term.
We can’t predict exactly how things will develop in Greece, but a ‘Grexit scenario’ where there was a No vote and Greece subsequently left the euro, is a distinct possibility. What impact would this have on European economies and in particular the UK?
There could clearly be short term adverse impact on financial markets and confidence more generally, but we do not believe that this should derail the broader recovery we have started to see in the Eurozone economy over the first half of this year. This reflects the fact that:
1) Greece is a small economy, accounting for less than 2% of total Eurozone GDP.
2) Broader contagion to Spain, Portugal and Italy remains a possible risk, but these economies are now stronger than they were in 2011 when there were first fears of Grexit and the ECB now has tools at its disposal – sovereign bond purchasing under QE in particular – to support these countries if their bond yields were to rise significantly. Any financial contagion should therefore be much more containable than it would have been has Grexit happened three or four years ago.
3) Exposure of the European banking system to Greece has also been significantly reduced since 2011-12. Most Greek government debt is now held by official lenders such as the EU, the ECB and the IMF, with very little private sector exposure. There will be more exposure to Greek bank failures, but again to a much lesser degree than three or four years ago.
4) Domestic demand has been strengthening in most Eurozone countries, helped by lower oil prices since last summer and continued very loose monetary conditions, courtesy of near zero interest rates and QE.
These arguments apply even more strongly to the UK, given that Greece accounts for less than 1% of total UK exports and that UK bank exposure to Greece has been reduced significantly from around $12 billion at the end of 2014 to only around $3.2 billion now according to the Bank of England.
Of course, some UK companies will be affected that do more business with Greece, including some well-known household names. The 2 million UK tourists going to Greece may also face some disruption, though they could also get a cheaper holiday there to compensate. There are also around 35,000 UK nationals living in Greece who may face financial disruption due to the crisis. But at the macroeconomic level, the negative impact on the UK economy should not be significant.
Some longer-term consequences are less predictable. Will credibility of euro be weakened by a Greek exit, or could departure strengthen the solidarity of the remaining members? Will there be broader geopolitical tensions affecting Balkan region if Greece becomes isolated from other EU countries?
There will no doubt be further twists and turns in the Greek crisis, but the main effects of recent developments will be felt in the Greek economy, rather than more broadly in the rest of Europe. In particular, we do not expect this to derail the recovery underway in the UK economy.